So You Want to Be a (Legal) Cannabis Entrepreneur?

It’s an exciting time to be in the burgeoning cannabis industry, where timing and positioning are key and the establishment of a brand can be essential for long-term survival and success. Sharing some similarities with both the repeal of alcohol prohibition in 1933 and the Internet boom of two decades ago, the cannabis industry is nevertheless unique unto itself—inviting comparisons to the spirit (and risks) of the Wild, Wild West, yet also demanding an aptitude and appreciation for technical complexity. It is a place for neither fools nor the faint of heart to tread.

The fact is that, as the cannabis industry moves fully out of the shadows, it is establishing itself among the most highly regulated business environments in the world, on a par with financial services, gaming, and health care in terms of depth and complexity within the regulatory framework.

Not only are cannabis businesses subject to state licensing and regulatory requirements, but their stakeholders must adhere to city, county, and federal regulations and authorities as well. Cannabis compliance can be a highly complex endeavor, subject to many pitfalls. If a business is noncompliant from a regulatory perspective, it risks losing its hard-earned privilege to operate, while facing stiff fines, penalties and probationary actions that threaten to handicap it at the very time that it seeks to bloom in the marketplace.

Compliance, in short, is imperative for survival. A look at nationwide compliance rates during 2016 found that cannabis businesses fell short of meeting many of these requirements, which cover a host of areas, including inventory and financial, security and surveillance, required business records, public safety, and others.
The most compliant state last year was Illinois, where cannabusiness operators averaged the highest relative scores in the nation: 97 out of 100. Such results might be attributed to the fact that Illinois regulators conducted more inspections per business than any other state with a legalization program. Due to intense regulatory scrutiny going forward, Illinois’s cannabusinesses simply cannot afford to be noncompliant.

Conversely, the least compliant states were Washington and California: Businesses in those states averaged more than 16 compliance infractions per inspection. The Washington and California markets have been largely unregulated since their inception.

How do marijuana businesses fail? Adherence Compliance, a provider of compliance software, partnered with New Frontier Data to find out. Based on the frequency of occurrence for all inspection types, the top infractions across 15 categories that Adherence Compliance monitors include the following:

Percentage of Businesses Failing at Least One Compliance Requirement

76% – Inventory and Financial. This includes the failure to reconcile all inventory on hand at the close of the business day, as well as over- or underreporting inventory in the state’s tracking system.

72% – Security and Surveillance. This includes the failure of security systems to have an unobstructed view of all activity on the premises, and a failure to maintain a current list of all employees and service personnel with access to the premises.

67% – Labeling, Packaging and Product Safety

64% – Required Business Records

53% – Transportation and Storage

Since the 2014 implementation of its adult-use program, Washington has assessed various penalties for failure to comply with cannabis production, processing and sale regulations. Written warnings and fines peaked in 2015 but declined in 2016, whereas the numbers of penalty escalations, suspensions and revocations all increased in 2016. The trend lines suggest that warnings and fines in the first two years of operation led many businesses to correct early mistakes, but that regulators’ patience waned by the third year, as they began targeting repeat offenders more aggressively with increasingly severe penalties for subsequent offenses.

For states with previously unregulated markets, new compliance requirements can prove to be very difficult to incorporate into current business practices. The inspection data from Adherence Compliance highlights how businesses in such states score lower when compared to states with new markets. For states starting fresh, compliance scores are dramatically higher than in states with previously unregulated marijuana sales.

The message to entrepreneurs, in other words? Fool them once, shame on you; fool them twice, it will cost you; fool them three times, and you probably should start looking for another line of work. —John Kagia & J.J. McCoy of New Frontier Data